What Is A Cash Flow Statement?

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A Cash Flow Statement is one of the most important documents that an investor must look into before investing in a company.

A cash flow statement records the sources and the uses of cash (and cash equivalents) of a particular company over a period of time.

Simply put, a cash flow statement basically tells us how much cash an enterprise had as at the beginning of a particular period, the sources from which it has generated cash during this period, the different uses to which this cash was put, and the cash balance as at the end of the period.

In a Cash Flow Statement, the cash flows are sub-divided into three categories. These are:

  1. Cash Flows from Operating Activities.
  2. Cash Flows from Investing Activities.
  3. Cash Flows from Financing Activities.

We will discuss each of these briefly.

1. Cash Flows from Operating Activities:

Operating activities are the principal revenue producing activities of an entity. Thus, under this section, all cash inflows and outflows relating to the operating activities of the entity are recorded.

For example, for a manufacturing entity, the principal cash outflows (spends) from operating activities would be the purchase of raw materials and labour wages and salaries. The cash it generates from the sale of its final product would be recorded as cash inflows from operations.

Note that purchases and sales are often made in credit. However, since a cash flow statement records the inflows and outflows of cash, credit sales and purchases are recorded only when cash is realised or paid.

2. Cash Flows from Investing Activities:

Investing activities are those activities which a company undertakes to bring about an increase in its future income through the acquisition of income producing assets.

Thus, for a manufacturing company the acquisition of a new machine would be a cash outflow from Investing activity as the machine would enable them produce goods that it can sell at generate cash.

Similarly, when a company acquires the shares of another company, it would record the same as a cash outflow from Investing activities. When these shares are subsequently sold and cash realized, we would record the same as a cash inflow from Investing activity.

3. Cash Flows from Financing Activities:

The inflows and outflows of cash that impact the capital structure of a company are recorded in cash flows from Financing activities.

The capital structure of a company outlines the way in which a company is financed. A company may be financed entirely through equity or through a mix of debt and equity.

Thus, when a company raises money through the sale of its equity shares in the primary market, the same would be recorded as cash inflows from Financing Activities.

Similarly, when a company raises fresh capital through a bank loan the same is recorded as a cash flow from financing activity. The principal repayments on this loan are also recorded as cash outflows from financing activities. (The interest paid to bank may be recorded as either a cash outflow from financing or operating activity.)

Importance of Cash Flow Statement from an Investor’s Point of View:

For an investor, a cash flow statement is important because it tells him whether the business is able to generate enough cash to sustain its operations and thus adding value or is destroying value by simply burning up cash.

However, before taking any investing judgement based on a company’s cash flows, it is important to analyse the cash flow statements over a sufficiently long period of time and not merely base your judgement on the cash-flow statement of a single quarter.

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